Every so often, you come across somebody who challenges the status quo with gutsy bravado, so when Pete Comley invited me to take a read of his free ebook on Monkey with a Pin (MwaP) about how various trials and tribulations mean private investors achieve nowhere near the returns they are led to expect on the stock market I took him up on it.

Monkey with a Pin is a well-researched diatribe on the ways that the financial industry fleeces the common man of nearly all of any gains he may achieve on the markets, and where gains aren’t achieved they take fees anyway. Just because they can.

It’s hard to argue with MwaP as a comprehensive statement of the problem. However, while there were lots of good recommendations in how to reduce the chances of getting fleeced in charges, I did find it lacking in actionable responses to the more general problem of realising a real return on investment in these desperate post-credit-crunch times.

Pete Comley says that he hopes that new investors should not be put off investing by his ebook. I’m not so sure that would be a rational response from them – the take-way I got from the book is basically for private investors old and new is

Step away from your online trading account. Very slowly. And observe Comleys Laws of Private Investing, taking after two of the Three Laws of Thermodynamics:

You can’t Win, because it’s a closed system

You Can’t Break Even either, because fees and charges leak away about 6% of any gains to be had. And the gains were only 5% in the first place, so result misery.

It’s a great read, and challenges many of the shibboleths of investing, in particular the 5% real ROI that is often bandied about, showing that this conveniently ignores all the dead companies littering the landscape. The finance industry comes in for a good kicking as well along the way as a whole range of nastly little sharp practices are exposed. If nothing else, it will ram home that you need to keep these guys’ hands out of the till as much as possible. A lot of that is up to you, in how you invest as well as what you invest in.

You should minimise your churn – I would venture that even the 100% annual churn that Pete Comley warns against is far, far, too high. Mine was 65% in year 2010/11 and 17% in 2011/12, and even those are too high. The first is because of some rank stupidity with BP and reorienting the direction to a HYP, the second due to some minor stupidity with BARC last year 🙂

I had come independently to his second insight, which is that you should also buy/sell in significant chunks (>£2000 for typical UK broker charges).

Monevator/TA had already warmed me up to the value of low-cost index funds such as HSBC’s FTAS and L&G’s LGAAAK as a low cost alternative to the ETF passive approach I had initially used, and MwaP reiterated this. I’ve never been drawn to managed funds, though I do favour investment trusts at times. And managed funds of funds looked like a swampy fees quagmire to me, though Vanguard’s LifeStrategy fund is arguably a passive fund of passive funds, which I’m considering for an eventual main index holding.

Index investing – a different view on why it works

Comley made a case for the benefits of index investing which was much easier for me to appreciate than anything I had found before. Although I could see from Monevator/TA the low-cost aspects, the analytical reason why index investing would be expected to have an edge on an investor buying typical index components seems to be that the index automatically kicks out the dogs that go bust, effectively dynamically rebalancing. This ‘survivorship bias’ is meant to be worth about 1% p.a. I hadn’t understood that before, nor had a feel for just how many firms do go bust over the years, and that gives me a more favourable view of index investing that just following all the other sheeple…

Am I a typical Pinless Monkey?

Statistically, I unlikely to have investing ‘hot hands’, i.e. an innate talent greater than my peers lying far outside chance. I’ve learned a lot of the issues in the book the hard way – as a speculator in the dotcom bust I churned, chased momentum, sold low and bought high, you name it. I did learn to avoid those things, indeed I feel a lot of investment success is avoiding the pitfalls rather than finding ten-baggers. Although the story of ten- and twenty-baggers is exciting, the main thing is learning to survive in the investment jungle, particularly if you are a stock-picker rather than an index tracker.

Over the last five years, I haven’t bought any stocks that doubled in price (with the exception of Sharesave holdings of The Firm bought in its existential crisis in 2009, which don’t count as I haven’t taken delivery of them yet) never mind went up tenfold, whereas in the dotcom era I did have this. However, I haven’t held any stocks so far that have gone down the pan, which I had in the dot-com bust. None of my current stocks have dropped by more than a third. The liquidation value is about 4% up on the total invested over two and a half years. It’s hard to know what that means, because of the shocking volatility of the capital value – the 4% has been up to 7% and down to -7% over the last year, and it ignores some dividend income that appeared as cash in the ISA. There’s just not enough data to say anything useful.

A Different Perspective on Cash

For various reasons, I hold much more cash than I would like, because the path of my future had a lot of uncertainty in it. It is about 50% of my post-tax financial assets and 100% of my AVC holdings now. I really hate cash as an asset class, silently wasting away every year without so much as by your leave. At least a good hunk of it is in NS&I ILSCs to which that doesn’t apply. I just don’t have Rob’s equanimity about cash, it’s a wasting asset in my view.

Some of that hatred is due to the bad press the financial industry gives cash, by not allowing for the fact that private individuals can get better rates than their benchmark, the Treasury rate. I didn’t really understand that beforehand, and it seems to have come as a surprise to Pete Comley too, so hat tip there for the heads up. I still hate cash as an asset class, but perhaps I should look more kindly on it given the rottenness of the alternatives!

Conclusion – All hope abandon ye who enter here

I learned a lot and got to see things with different eyes from reading MwaP. However, the overall message I took away was somewhat cheerless, it is basically as far as stock market investing is concerned,

The takeaway message for me as far as the stockmarket for private investors is the inscription above the gates of Hell in Dante's Divine Comedy - All hope abandon ye who enter here

I couldn’t see the up-side. My feeling is that on the whole the reason stockmarket investing should work is because you’re effectively buying a slice of a company, which is a real operation that is creating real value somewhere, and that people will beat a path to its door in search of that. I know, it’s sometimes hard to see where the benefit is in somewhere like MacDonald’s, or Goldman Sachs, but anyway, I’ll pinch the words from Warren Buffett speaking in 2011

My own preference — and you knew this was coming — is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola (KO), IBM (IBM), and our own See’s Candy meet that double-barreled test.

It is possible that I misunderstood the thrust of Pete Comley’s work, but he appears to discount the validity of one possible response to the costs he correctly rails against. That is to buy and hold. Unfortunately, Comley comes to the conclusion that we are in a secular bear market (it’s a real pain that you can’t reference an ebook! The best my Kindle says is Location 2827 of 3880)

Buy and hold is predicated on the assumption that the market will offer a good rate of return. That seems unlikely in future.

To some extent I agree with him when he modifies that by

… strategy likely to be effective until the next secular bull market arrives is one of buying shares only when they are very cheap by historical standards and then holding them.

Cheap in this case is for the S&P to have a CAPE of 5, rather than the current 20-ish which is above the long-run average of 15.

I entered the market with my AVCs in March 2009, just after I misinterpreted a performance review that I was headed out of The Firm. At the time everybody was down on shares, and indeed I also thought the centre wouldn’t hold. It seemed worth a go, however, because I was otherwise doomed anyway – I hadn’t made enough preparation to retire early. The next week I read this which stiffened the spine somewhat, and I hit the global index fund AVCs hard with over 2/3 of my salary for a few months.

I liquidated that in March, turning it to cash. It was 20% up (though inflation has eaten 10% of the value of money since March 2009). It is easier for someone who believes that they have nothing to lose to take action in a crisis than someone who fears the loss of all they have in the status quo. My hope is that having threaded my way through the eye of the needle once I may do so again, for instance when the Euronuts finally raise the white flag over the twisted wreckage and surrender to the tanks of reality crushing their dreams of one single currency to bind them all. In that maelstrom fortune may favour the independent of thought, though as MwaP says,

such periods are so accompanied by ones of negativity, extreme volatility and downright repulsion for shares that you have to be an extremely well-disciplined and far-sighted investor to take advantage of them.

Therein lies the rub. To get exceptional results, you have to take exceptional actions. Fly into the storm, when all around are flying away. What does not kill you makes you stronger.

Perhaps my inner Virgil paused at the gates when my Dante went through the arch and lost his way. I can see how readers might be able to use MwaP to hugely reduce their losses, and that alone makes it definitely worth a read. But I’m damned if I can see how they might be able to use it to improve their gains. If it encourages future victims of the rapacious financial services industry to exit their brokerage accounts and sit firmly on their hands then perhaps that’s good enough 😉

Warning. This is a rant. It lacks charity and the milk of human kindness. This sort of thing happens when you discover other people spend more of your income than you do…

I received what is probably the last P60 form I will get. This is a form that states earnings and tax paid over the year 2011/12 up to the 5th April. I learned that I paid more in tax and National Insurance this year than I have been living on. To the tune of 60-100% more. That’s right. If I retain my car in the coming year I will have paid 2/3 more tax as I am living on. If I don’t keep the car it will be 100%; I will have paid two years’ worth of running costs, in tax. For some strange reason that really pissed me off. It’s not even as if there is any 40% tax in there, FFS!

How the P60 looks to an Ermine

I’m really, really, sick of paying for other people’s children’s private school education and the general benefits culture. And I’ve done my bit for society, I paid too much 40% tax before discovering how to avoid it and turn it into something that works for me using AVCs.

I used to think it was only swivel-eyed nut-jobs that talk about the Laffer curve. Either I have become one of those swivel-eyed nut-jobs, or the Laffer curve swings dramatically to the left for people of independent means. For the benefit of any of the real nut-jobs Laffer never said that you increase tax revenue if you cut taxes. He merely said in some cases you do. I have never paid 50/45% tax, and never been near. As a retiree I will be a 20% taxpayer, but nowhere near the 40% tax rate unless it keeps coming down.

The idea of the Laffer curve is if you tax people too much, and they give up and work fewer hours or retire early. Well, Q.E.D. in my case perhaps. Tax too little and you obviously get nothing at the limit case of a 0% tax rate, tax at 100% and everyone will be on benefits, so it is postulated that there is a optimum point, where Government realises the highest revenue. The French finance minister Jean-Baptist Colbert put it far more elegantly in the 17th century

The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing

I’ve been plucked enough, thanks. I will never get any benefits*, because most are means tested on capital assets. I’d be lucky if I get my State pension in 16 years’ time, because no doubt that will be means tested by then.

an Ermine is not a Goose and he doesn’t like his fur plucked…

I am already over the tax threshold if I take my pension, indeed some of the incentive to take it early and use investments to make up the actuarial reduction is to slow the invisible hand of the thieving barstewards of the government getting their mitts on more of it. I’m seriously looking at using a VCT to lose enough to get below the tax threshold if I have a desire to earn money in future. A VCT is to be looked at more like a lottery ticket rather than an investment, however, one discounted by 30% tax saving.

The reason is I want to be able to play with microfinance and dabble with various ways of making small amounts of money, little bits of writing and perhaps the odd bespoke electronic gizmo, if there is a business case in the horrendous regulatory burden of CE marks, RoHS and testing that’s arisen since I last manufactured electronics for sale. It’s probably not going to be a big part of my life, but I want to see if there is some entrepreneurial streak in this salaryman.

However, I can’t relate to giving up 20% of a lousy £100 earned that way, it would just really piss me off, and most of the ideas I have are non-physical things like writing and software, where you can’t write any input costs off to tax, they are the pure product of mind. I’m not going to rack my brains writing for the frickin’ government to pay for Ray’s Sky TV, thanks all the same. Unless it’s successful enough that I’m earning £2000 or more, in which case I guess I am no longer retired.

Now if I can’t drop my taxable income so I can capture 100% of the fruit of my micro labour then sod it, I’ll not bother, I don’t need to earn money through working, and I don’t have a Calvinist world-view that work is good for the soul. Ian Duncan Smith can stick his work till 70 right where the sun don’t shine in my view.

I am actually prepared to throw away the excess over the tax threshold, in VCT lottery tickets, or in paying an accountant to find a way for me to buy trees or some other slow-paying capital asset to write off as an input cost. Part of the problem is I have never been a sole trader, my previous non-employment forays were as a limited company which precludes lowering one’s personal income thereby reducing tax liability.

The endless fight over the last three years to keep the thieving hands of the taxman off more of my earnings has highlighted just how much of my lifetime earnings disappeared in tax, and I just don’t want to feed the Beast any more. I’ve done my share over the last 30 years and that’s fine. In the unlikely event that I do get a State Pension they will no doubt be back for more tax. Until then, back off, guys.

Don’t come away from this thinking I would have benefitted from Osborne’s tax cuts – I am not even in the top fifth of the UK income distribution, though for some reason I am further up the UK wealth distribution.

I didn’t inherit that wealth. I am further up the wealth distribution than I was up the income distribution for two reasons

The difference between what I spent and what I earned is my accumulated wealth. I paid taxes on earning it. Unlike disciples of Ayn Rand, I don’t have too much of a problem with that. In the end I have no desire to enter the fear and loathing that is the US healthcare system, and the history of the privatised services show some services are better done in the public sector. Our water supply and railways were all more reliable in my experience before privatisation. The old Water Boards actually built reservoirs in the 1970s in response to droughts, and though the food was rotten, you didn’t have to raise a small mortgage to travel by train in the 1970s, and you could establish what the price of a ticket was a straight function of destination and timing, rather than the byzantine mess it is now.

But what I do have is a problem with being taxed after I have taken major steps to pay my own way. I probably won’t get a State Pension because the buggers will means test it and conveniently ignore my 30 years plus of NI contributions.

In theory I could claim tax credits or Universal Credit. If the government pisses me off so much I will do just that, just to get my own money back. It really is bizarre that I could be entitled to benefits just for watching the TV all day. What the hell is the point of me paying tax, and then going to the Labour Exchange and claiming the same money back? Where on earth is the sense in that, it’s a waste of my time and the DHSS’s time. This is all part of the anomaly of having a low starting tax threshold, and an outrageously low starting NI threshold.

I’m not saying all tax is bad, and my 30 years of it should entitle me to the benefits of the NHS, and returned my debts to society in terms of schools etc. But when it’s getting to the feeling that I have no wish to use my modest talents to create wealth because of the Beast on my back then something is deeply wrong.

This is the counterbalance of bollocks like this, and it damages the UK economy when people who can create things and ideas choose not to. Somebody might want one of my telemetry systems, and if they pay me for it I might spend the payment on crisps and beer, and it would presumably reduce their business costs or allow them to do something they couldn’t otherwise do. Likewise if I interest someone with my writing and it makes me money. If we want to keep a relatively high level of benefits then a high level of taxation is needed to service it, and some people get to write intemperate rants like this rather than working out how to make useful goods and services.

Benefits are there to compensate for transient economic discomfiture caused by losing your job, and also to collectively support those amongst us who for reasons fo physical or mental incapacity can’t work. What seems to have happened is the benefits blanket has widened to encompass those who won’t work, or support lifestyle choices that are beyond their means.

Don’t get me wrong. If I could live in a world where the Fairness Fairy waved her magic wand and we all got to live the lifestyles we wanted to without reducing other people’s quality of life by taxing the crap out of them, I’d be all for it. In the 1970s I was told that we wouldn’t need to work more than two or three days a week and would struggle to find what to do with our leisure time. Unfortunately what happened was that people invented things like iPads and mobile phones, bottled water and Sky TV, so everyone feels they need to spend more money to pay for all these things. Not only that, but half of the promise came true – the world of work only needs about half of the number of people that want to buy all these things.

Thus we have the tragedy of there being jobs for about 60% of the people who want them, but these jobs demand a higher level of skill than many of the potential candidates. However, until recently we believed enough wealth was created in the economy that we could pay a lot of the 40% either middle-class pay by inflating the number of jobs in Government, or a acceptable working-class standard of living in benefits, particularly if they had children or if they claimed to be incapacitated. Only in the last five years did we discover a lot of that wealth was borrowed money.

The losers from this policy are spread across society. The young in general seem to be getting the short end of the stick as the world they expected to move into has been suddenly hammered. The truly incapacitated also take the shaft, because they get lost in the noise of the numerous malingerers cluttering up the system. Those who have built unsustainable lifestyles on the benefits teat are also going to be mightily dischuffed when the gravy train starts to dry up.

Addendum – The Ermine gets an upside for baring his needle-sharp teeth in the mirror!

One of the benefits of writing the first draft of this intemperate rant a week or so ago was that the whole concept of paying too much tax even as a retiree pissed me off so much I reinvestigated the technical reasons that made me believe I had to draw my pension immediately on leaving The Firm, to get a Sharesave scheme that was particularly advantageous. I discovered that the technical reasons ceased to apply to me earlier this month, and since I am still on the payroll I can defer my pension and still get Sharesave.

Since I can only get £10k a year into a S&S ISA there’s no point in liberating my pension commencement lump sum early and then stressing how can I invest a cash lump sum so it doesn’t get destroyed by inflation. The Firm’s AVC cash fund is good enough 1, and tax-free. So I don’t need to become a basic rate taxpayer, and I may now consider doing some of those microfinance jobs because I will be so income-poor I won’t pay tax on them. As well as that, an additional benefit is each year I don’t draw my pension it goes up by 5% (because the reduction due to early retirement is less), though since I will be a 20% taxpayer on it the increase is in reality only 4%. It’s not easy to get that sort of return on cash at the moment.

There’s also a more indirect business case for delaying my pension for a few years, also due to the distorting effect of taxation. There is an ambition to lift the UK tax threshold from its current £8000 to £10000 over the next three years. Saving 20% of £2000 is £400 worth of tax I don’t have to pay, adding up to £1200 over the next three years. It isn’t a lot of money, but I am sure I can spend it better than the Government, and it compensates me a bit for not having the utility of the money now. I also don’t need to buy expensive VCT lottery tickets until I can get my head around the issues. And I have more years to sling the redundancy money into ISAs before I have to work out how to invest my pension commencement lump sum.

*That paragraph was written before I discovered I can defer my pension, which opens up more opportunities. I may well claim working tax credits, if you can’t beat the buggers, join ’em… In which case the statement I’ll never get my go at the benefits teat won’t hold. I still won’t build a lifestyle on the extra money, though. I’ve seen what happens to people that do that and it ain’t pretty.

One of the disadvantages of saving money in a shortish time to retire early is you get a whole lump to manage at once. ISAs are designed for people who save in a civilised and steady way, not in a mad rush to get out of the workforce before the edifice falls around their ears. SG and TNT are great examples of how to do that task right, well done those guys!

I have saved a six-figure sum in pension AVCs, up to the absolute limit that I can save (25% of the total FS fund value) before being forced into an annuity for which I am too young. All the AVCs have to be converted to cash, which has already happened, then tax-unwrapped as a tax-free wodge of cash on leaving work.

The tax system identifies people with lump sums as rich bastards ripe for the picking so it’ll take me over 10 years to get the equity part into ISAs. I’ve made a hash of the post-work tax planning. For technical reasons I will have to draw my pension, actuarially reduced because it’s early, but still over the putative £10k basic rate tax threshold for 2015. So I need a long-term investing strategy, to give me an income for the next 40 years. Preferably one that doesn’t add to my tax burden.

Pensions are designed to avoid investing a lump sum all at once – either you get a defined benefit, like mine, or you have restrictions placed on how you draw down your pension or have to take an annuity. That is to avoid retirees blowing the lump sum on as frenzy of cruises and fast cars, resulting in penury afterwards. The most common question I’m asked when people hear I’m leaving with a payoff is ‘what am I going to spend it on?’ It’s a strange way of thinking. I’d rather give the lump sum a chance to earn some money before running it down 😉

There’ll be some people that will need to invest a lump sum like me, so this post might be of some interest in showing the thought process. It’s not advice – I might screw things up, and my risk tolerance and background are unusual in some ways.

A strategic overview

Initially, my pension is easily enough for my running costs plus a reasonable entertainment budget. It is to some extent RPI linked, but I will slowly lose the fight to inflation as the decades roll by. Inflation contains a lot of consumer frippery and iFads that I don’t consume, but which generally come down in price due to technological advances. Needs and services tend to go up over time. If I buy less of the stuff that is getting cheaper relative to the stuff that is getting dearer then overall I will experience > RPI inflation.

I started work in February 1982, without any long-term vision or strategy of life. You can get away with that at 21 because you have fifty-odd years of life remaining (as it was at that time, current 21-year-olds will be happy to know they are up for nearly sixty years from now).

It looks like I have picked up a decade of life expectancy in the intervening 30 years, I’m not sure why. I’m up for another thirty years according to the ONS. So I probably stand pretty much midway through my adult life. If I look at my family history I might be wise to think in terms of income for 40 years, rather too much than too little…

Let’s just get up in the crow’s nest and look out for icebergs in the seas ahead. What’s likely to happen in the next 40 years?

Relative decline of the UK (short, med, long term)

I expect the UK to fall down the pecking order over the coming decades, largely due to our decadence and nasty tendency to live beyond our means, combined with the rotten state of the education system because we don’t dare discriminate between the bright and the dim bulbs in case it hurts the dim bulbs’ feelings. We may turn this around – there is probably enough nascent dynamism in the country and the British have a decent track record of resilience in the face of adversity, but the low-water mark is still some way off IMO.

A relative decline doesn’t necessarily mean an absolute decline. Living standards in the UK have fallen in the last couple of years, but compared to the 1960’s London I was born into, we enjoy a fantastic standard of living. The problem is that humans are relative – people felt better about their lives in the 1960s than they do at the moment, because they felt things were looking up.

Far from abating, the euro crisis has recently taken a turn for the worse. The European Central Bank relieved an incipient credit crunch through its longer-term refinancing operations. The resulting rally in financial markets hid an underlying deterioration; but that is unlikely to last much longer.

The fundamental problems have not been resolved; indeed, the gap between creditor and debtor countries continues to widen. The crisis has entered what may be a less volatile but more lethal phase.

There are opportunities there. That explosion will probably trash share prices across the region, possibly the world. The brave and the reckless, who are prepared to fly into the storm rather than trying to run before it, may find value is cheap as they pick over the wreckage. The successful must have internal reference points. When the falcon cannot hear the falconer and the centre loses hold there will be no external references to steer by.

Will I hold my head when all around are losing theirs? Buggered if I know. I’ve seen three recessions up close and personal and was a teenager in the 1970s oil crisis and stagflation. I was a heavy investor in 2009 after appreciating the logic behind this, indeed looking at my AVC contributions I stole a march on the article by a couple of weeks, but it did stiffen the spine. However, desperation concentrates the mind, and a 40% tax-free discount makes courage easier. Even a dog can be a great investor with a 40% leg-up.

a multipolar world (med, long term)

The power centres of the world economy are shifting, and it’s not really possible to say where they are shifting to. America is bankrupt but has the advantage of being the money creator of last resort, China is an enigma within a conundrum, they seem to be top dog at the moment but it is questionable if they will get rich before they grow old. India seems well-placed, though it could do with reining in the backhanders. Russia, well, do you feel lucky, punk?

It’s pretty unclear where the engine of growth will be in the decades to come, or if there will be one. We will have resource wars, beginning with oil wars. We’ve already had a few, Iraq and Libya spring to mind, Iran is on the hit list. As for that growth, perhaps Uncle Sam will dust himself down, spit on his hands and show everyone how it’s done. Maybe Africa will do something with all that Chinese money and a few of the rotten ageing dictators will get bumped off and the economies soar. Perhaps Peak Oil will come along and the entire economic system must fall until some of us work out whether trade still has any meaning in a energy-starved world. Who knows?

Go East young man – diversify

There’s only one way to handle that lack of knowledge – bet on several outcomes! Diversification comes in to flavours, coarse high level asset class diversification and fine level equity diversification, equities being a subset of the asset classes. I have now lost all equity geographical diversification from the UK, which I had emphasised in the AVC holdings.

Monevator has a listing of asset allocation strategies in his Lazy Portfolios Make Asset Allocation Easy post. That illuminated my thinking greatly, though I was initially confused as hell because all but the Harry Browne portfolio as asset allocation strategies as it said on the tin, but the Harry Browne one is in fact a asset class allocation strategy with a 1970’s era equity allocation.

1. Allan Roth. Nope. I may be reckless, brave, even mad, but I’m not young.

2. David Swensen. I’m not an Ivy League endowment fund with a 100-years plus investment horizon. Not unless we go through the Kurzweil singularity and I don’t know about you but I’m not sure I want to live for ever in a world of beings increasingly smarter than me.

3. Rick Ferri’s Core Four

Too much developed world for my liking. I think the developed world is likely to become a lot less developed over the next 10-20 years. So it doesn’t meet with my world-view. Rick Ferri may well be right, but heck, it’s my life so it has to go along with my beliefs, even if I turn out to be wrong and this sort of thing happens.

4. Bill Schultheis Now we’re getting somewhere, the spread is similar to my mind to Tim Hale’s which I preferred but this is the first one I’d be happy with in terms of equity asset spread (I lop out bonds and gilts from every spread because of my specific circumstances of having significant fixed pension income)

5. Harry Browne’s Permanent Portfolio. Fascinating geezer, Harry Browne, with his seminal How I found Freedom in an Unfree World. He’s somewhere to the right of Ayn Rand who looks like a pinko Communist in comparison so it’s kind of disturbing that his was the one that really resonated with my world-view. It matches my expectation that there are serious challenges ahead, his choice of four orthogonal asset classes is what I like. His domestic-only equity target is very much of his 197os world where the developed world ruled, so it needs adapting to the modern world. It’s more an asset class allocation strategy.

6. Six Ways from Sunday. I just didn’t get this, so no dice. I actually share Scott Burns’ viewpoint that energy is the ultimate currency, so I did pinch one ETF idea from him.

7. William Bernstein’s No Brainer. Same issues to my eyes as Rick Ferri’s portfolio, too much developed world IMO.

8. Harry Markowitz. Attractive simplicity. I don’t do bonds because of my special circumstances (a FS pension that is pretty close to bonds in characteristics of fixed and index-linked income). I probably want to weight more than the World ETF, but if I had a DC pension sum to invest this has a lot to be said for it., Being a fiddler, I’d weight to the UK (because that’s where I am) and after that underweight the developed world (because of my world-view). Thereby buggering up the simplicity, so not right for me and my resources.

9. Tim Hale – much to like here, though again I’d lop out the government bonds and index-linked gilts due to my specific circumstances. And translate the Vanguard funds into something I can access in an ISA without paying the earth. The bonds and gilts I’ve eliminated is 40% of the portfolio, but the capital value of my FS pension is a lot more than the free capital I am investing, so taking a high-level view I am overweight fixed income. I may get his book from the library to catch up with his thinking. I will use the equity distribution to illuminate my equities later.

25% stocks in the country you live in, 25% bonds, 25% cash and 25% gold

But since I’m an inveterate fiddler, and prepared to accept the consequences, I will consider this as

25% equity portfolio

25% bonds I shall consider my final-salary pension

25% cash I will hold as NS&I ILSCs (I don’t know what a money market fund is, this seems to be US-specific)

25% gold I will consider as including my non-financial investments.

I don’t know what Harry Browne was thinking of doing with his gold, but if he considered it his SHTF Bug-out stash I wonder if he considered the weight of it, he was a lot richer than I am and it was cheaper in his time. I wouldn’t want to run with it, particularly with in the form of coins. I may add some in the form of an ETF, but I’m happy to think about that later. My non-financial investments also fall into a similar role in that they gain as the financial system falls, but they don’t have the portability or divisibility of gold.

We should also remember that Harry Browne lived in a country where householders are encouraged to keep a shotgun handy and are entitled to take down intruders within the curtilage of their property. In Europe we are somewhat namby-pamby and effete for such gung-ho defence of one’s chattels, so holding physical gold is a lot less attractive for me than for Harry Browne.

Now the majority of my free cash savings come from pension AVC savings, and by the time I leave I will have driven this all the way to the 25% tax-free pension commencement lump sum limit. Given that the pension itself is in the fixed interest part, I’ll never balance that at 1/4, it will always be bigger.

this is not a canonical Harry Browne asset class spread but I start from where I am

Well, always bigger until this prediction comes to pass and the shares section eats the lot like Pac-man. Rebalancing keeps the right-hand-side in relative proportion but the whole would squeeze down the pension section 🙂 The reason the fixed interest isn’t 3/4 of the pie is because I have existing savings and the non-financial assets are substantial. And no, I still don’t include my house as part of my net worth because I have to live somewhere.

It’s obviously not pure Harry Browne because the cash and non-financial investments put together are about the same as the shares, which reflects my prejudices. I’m easy with that. I understand Harry Browne’s rationale and if I were working up from scratch over a working life I’d stick to his equal split. But I’m not, so I am going to do it my way, and take the hit for being an opinionated git if necessary.

The equity part of the Harry Browne portfolio, updated with Tim Hale

So I’ll take the equity portfolio, retain my HYP which is largely UK based, and already includes Aberforth for UK smallcap, turning it into a bastardized Hale variant like so:

20% HYP (for the UK part)

5% Aberforth Smaller Companies

20% s Dev World ex-UK Equity, consisting of four HSBC funds as used in the slow and steady portfolio. Asia Pac seems to be developed world in investing terms.

16% some sort of Global Emerging Markets LGAAAK seems to fit.

6% db x-trackers Stoxx Global Select Dividend 100 ETF (XGSD) TER 0.5

No, not doing any sort of index-tracking select dividend. I got slaughtered with IUKD a while back until TI educated me and TA showed me the 4% running costs that, basically, you can’t automate value plays. The huge attractors of value traps will always kill you. If you want to file that flight path you have to fly it on manual, or get sucked into the black holes on auto.

I’m going to swap that sucker with a gratuitous addition from Scott Burns’ portfolio to reflect my views on impending Peak Oil. And yes, it probably does overlap LCTY to some extent, life is just like that. It’s nothing like what IUKD is claimed to do, but since a HYP has a bias to what IUKD should do but doesn’t I don’t feel value is unrepresented.

9% Global exUK DW SmallCap

10% HSBC FTSE EPRA/NAREIT Developed ETF (HPRO) – this is property

10% Lyxor ETF Commodities CRB (LCTY)

10% db x-trackers Stoxx Europe 600 Oil & Gas ETF (XSER)

The proportions are higher than in the original article because I have chopped out the 40% for the gilts and Government bonds, which I don’t need, due to my fixed income.

There’s a lot of noise and hum associated with running something like this, so many funds, and rebalancing. Passive investing bores the bejeesus out of me, so one attractive alternative is to buy a Vanguard Lifestrategy 100% Equity fund ISA from Hargreaves Lansdown and be done with it. And then do the same next year. And the next. And the next, and so on. The HYP would skew that to the UK somewhat, but so be it.

The one thing that scares the hell out of me is Vanguard is so astronomically big. Big rewards mean big temptations. Somewhere, in that big monolith, I am sure there may be a young Nick Leeson or Bernie Madoff in the making, dreaming of riches beyond belief. Perhaps he is there right now, sitting behind the glowing light of a computer terminal in a ventilation shaft with nobody looking over his shoulder. Power corrupts, and it only takes one of them to get through…

ISA and temporal diversification

The annual limit on ISAs may work to one advantage, enforcing temporal diversification. Just as if you are going to quit the market to buy an annuity you should wind down your position over five years, the reverse is true on entering it. As it is I need > 5 years to enter anyway. There’s an argument to say I should use several ISA providers too, but this mitigates against rebalancing, as holdings in separate providers can’t be rebalanced across the divide. This isn’t a problem in the early buying years, but once the ISA has reached steady state it is. I’ll probably compromise and keep the HYP with iii and use a different platform for the rest.

What’s with all this passive rubbish all of a sudden?

I’m unashamedly active with my HYP, in the choice of what to buy, though I try and be Buffetesque in buying and holding; my churn is low, trading is not something I have any skill for. The income from that will be the first line of defence as my fixed income falls below the waterline. The UK is not a bad place at all to seek income from a HYP.

I can do okay with a HYP in the UK but if I want a slice of anywhere else I either have to pay someone like Anthony Bolton to understand it or I can go passive. There’s no point in me trying to pick stocks in areas I only know of as shapes on a map, but I’d like exposure to them. So the scattergun approach of passive investing becomes attractive in the face of no cheap alternatives.

Passive investing gives me concerns in big developed world indices tracked by lots of ageing Baby Boomers about to sell out of the stock market on retirement, like the FTSE100 or the S&P500. I don’t track the FTSE100, and I hate trackingthe S&P500 and would avoid it if I could – I’ve split the US one into 3% S&P500 and 2% US dividend aristocrats because doing the same as everyone else is never a good thing in investing. There seems no S&P allshare open to me. For all the other global stuff which won’t be tracked by loads of people I am relaxed about passive investing. In the end I want to do other things with my life than obsess about far-flung stock markets.

Perspective is also important. I will add value to DW’s project and the time may well come when my financial assets will be less significant. She has managed something I only managed on the side – and that is capturing the entire fruits of her labour by working for a company owned by herself.

There’s a common thought-pattern that you can never become rich when you trade your time for money. I love the American directness of this straight-between-the-eyes approach

This might offend some people, but as long as you are working for someone else, you are not working for yourself. With that kind of attitude, you are actually thinking as a poor person does. If you are not investing into yourself and your own business, you are going to stay in the position where you are.

I can’t complain too much, I did okay working for other people, and wasn’t entrepreneurial enough to work for myself full-time. I don’t regret it – in the end you will only know joy if you can recognize what enough looks like, and it looks different for each one of us.

I will be retiring about eight years early, or, as far as the Government’s expectations are concerned, 14 years ahead of time. Here are five tips on how to get there.

From age 25 I managed to do 1 and 2 of these, and as I came within five years of retirement I did the whole lot.

spend less than you earn

never pay interest to borrow money for consumables, only productive or cost-reducing assets

save six month’s running costs as an emergency fund

pay off your mortgage before you reach retirement age, preferable five years before so you can use pension tax breaks to the full

minimize fixed recurring costs such as mobile subscriptions, Sky TV, gym and magazine subscriptions. Of those you keep, make sure you get utility from them.

I’ve had good luck in some areas, such as being employed 95% of my working life, and unemployed only 1.6% of it (the rest was when I did an MSc with a grant), and having a final salary pension in a company with a normal retirement age of 60. I’ve had rotten luck in other areas – buying my first house in the Lawson boom and writing off half of it to negative equity. I trashed over £10k chasing momentum in the dot-com bust. But these were mistakes I could afford to make. You can be too fearful of making mistakes – and then you will never take opportunities. Getting the balance right is the key…

I am not a City banker, my job probably classes as middle management if equated to the rest of The Firm. Earning a little bit more than the UK average isn’t the secret to early retirement. There are plenty of people who earn a lot more than I do but can’t make ends meet. The secret to early retirement is pretty much in these five tips on how to stay on top of your finances over a working life-time. These are strategic and high-level rather than immediately actionable. Indeed, if you want to use them it helps to start at half my age 🙂

They worked for me, and I’m toying with the idea of going along to the Write on Finance Blog Up in Leeds. I will have finished work by then, and DW has identified a Turkish Baths at Harrogate which is 12 miles away. She has a weakness for that sort of thing. And I’ll take the opportunity to say hello to these old friends, the Devil’s Arrows, as mediaeval Christians titled the three prehistoric standing stones by the side of the Great North Road.

Devil's Arrows, Boroughbridge

I like that. There is something special about a construction that has been standing sentinel for four thousand years.

He’s got a point. Why so little? Well, whenever I hear middle-aged people talking about how to store wealth, there is one strategy that they focus on, that wouldn’t appear in the ISA tally. It stands head and shoulders above anything to do with shares, gold, or setting up a business, which is kind of strange for a country that has made finance its engine of growth in a post-industrial era.

I come across it time and time again, so often that it must either be a sure-fire winner, or there must be something else unusual about this radiant flame that is circled by an endless number of moths.

Most of these folk have had regular salaried jobs for a while, that pay a steady income, month in, month out. Until, that is, that fateful day when the backdraft of downsizing comes its way, or they come to pick up their carriage clock and sign out of the office for the last time.

So what they really, really, want is an income like that job, or that’s reliable as they used to remember. They want a steady monthly income. And to many, many people, the first things that springs to mind is a highly unusual investment, that has a typical capital value performance over time that looks like this in real (inflation adjusted) terms.

It’s residential housing, better known as buy to let. Now the good thing about this capital performance is that it’s generally on the up. The bad thing about it is that you can get slaughtered in it for ten years at a time. I should know, I’ve been there.

Buying your own house

Everybody needs to live somewhere, and if you are planning to stay in one place for a long time (> 10 years) then buying the residence you live in is generally a good move.That 10 year condition is a big ask in today’s job environment. If you’re going to move, then it’s best to be able to do it at a time of your choosing, and indeed some BTL owners are accidental landlords who couldn’t sell their house at a price they wanted when they needed to move elsewhere.

Even if you screw up like I did buying in 1989, after twenty odd years the slow uplift compensates somewhat. If the mortgage and house maintenance you pay is less than the rent you would be paying on the house you get a cumulative benefit from it. However, what you can guarantee with you own property is no occupancy voids, and hopefully the residents don’t trash the place either 😉

Even buying your own house isn’t risk-free, however – as well as market risk it is such a large undertaking that you can end up out of pocket if you fall on financial misfortune and become a forced seller or worse still a repossession.

You’re already highly exposed to the graph above through the value of your own house, though it isn’t as bad as it looks because once you own a decent amount of your house if you are selling at a low point you are buying at a low point too, which is what saved my tail in 1998.

Such a good deal, many people want to do it again!

So people then extrapolate, and want to own another house for other people to live in. There are two variants of this. Some, looking for somewhere for a store of wealth, simply want to buy and get the rental income. Others want to gear up, borrowing money using a BTL mortgage, using as little of their own money as possible, as advocated here. Your house is normally your largest asset if you own it outright, so doubling up your exposure to the same type of asset is a huge unbalancing of the asset classes you use to store your personal wealth. It so happens that this asset class has done pretty well over the last 20 years, though it’s taken a few hits of late.

Now there’s nothing fundamentally wrong with this, provided you have asked yourself if this reflects your particular attitude to risk. Maybe you have particular skills working with houses, or tenants, or renting to students. You can use other people’s money, in the form of a mortgage, at low interest rates to gear yourself up. Which is great when house prices rise or there is high inflation, but it’s hell when they fall. I know this from personal experience.

That was twenty years ago, so a generation has grown up to believe that house prices only ever go up, and those that know otherwise tend to keep schtum. Never underestimate the soulless feeling of paying hundreds of pounds towards a mortgage that is higher than what you sold the house for. At least if you throw tenners on the fire you’d get warm from them!

What’s so attractive about residential property as an investment, then?

On the plus side

in principle it can give a regular income, voids excepted.

profitability is helped by tax breaks on interest payments

everybody has familiarity with the product.

On the downside

the capital value is volatile

This investment comes in big indivisible chunks

There is no geographic diversification

it is a high-maintenance operation showing people round and you have to get notice letters exactly right

there are a lot of hidden costs like letting agents, repairs

Some of these downsides would be addressable by residential real-estate investment trusts but I don’t know of any. It is a shame, because it isn’t just prospective buy-to-letters that would be helped with residential REITs.

Such instruments would allow prospective house purchasers to save their deposits in an asset class which reflected the price of what they were saving for. This would tackle a frequent complaint, which is in the recent past as you save towards a 20% deposit on a house the price races away from you. Residential REITs would lift the value of your deposit as you save. At the moment the only way I know of to simulate this is with spread-betting. Obviously if house prices drop your REIT drops too, but if you are saving for a house that’s not as bad as it seems.

However, in the absence of residential REITs, which could fix the large lumpiness, intra-UK geographic concentration and maintenance, that’s a lot of downside, particularly when you take the shocking lack of asset class diversification into account, which begs the question

What’s wrong with the stock market?

Two things are primarily wrong with the stock market. Everybody can see or touch a house, and provided they hold buildings insurance they feel it’s solid, reliable and will always hold value. Unlike some shares – in my earlier dotcom forays I held Videologic, Rage software, Ionica and Pace microtech. Rage software and Ionica went bust. You can’t argue with the logic that a house won’t go bust 🙂

The second thing people feel is wrong with the stock market is that they can’t see how to get a reliable income out of it. There are various strategies you can use to get an income – a high-yield portfolio, High Income funds, an annuity if you’re old enough and don’t mind your capital eventually disappearing, but none of them offers the comforting constancy of income that a salary or that regular BTL rent cheque does.

You need to have a much higher, almost entrepreneurial risk appetite to deal with a varying income, and better money management skills, which usually involve having a large float of a couple of years’ worth of essential living expenses. Now that isn’t your typical Brit, who relies on standing in the firehose of income supplemented with a good dollop of consumer credit to smooth out the lumpiness of running costs.

The sort of people that are looking to BTL as a way of preserving as lump sum can cope with the variable income because they have capital. However, I know personally that it takes a huge wrench to contemplate a variable income if you aren’t used to it. I have several years worth of living expenses in cash and I still bottled it, so I have arranged my affairs so I have a fixed income that keeps the wolf from the door and a variable income that is entertainment and investment budget.

I’ve got every sympathy for the desire for a fixed income, but sometimes a fixed income comes with a high capital risk, as investors in Keydata know to their cost. BTL is nowhere near that risky, but the steadiness of the income is only steady if you close your eyes to the fact you can lose a big chunk of capital. A diversified HYP has the same sort of risk – the stock market can fall 50% in a bad year, but because you can strategically enter it over a period of about 5 years you’d be unlucky to take such a bath on your total investment, provided you invested in a diversified basket of index funds, or diversified bunch of shares in different sectors and geographies.

Someone who isn’t used to the principles of sector, temporal and geographical diversification may favour an investment they understand that pays a regular income in a way they can understand. Compared to regular rental income, the uncertain proceeds of a HYP and evaluating how stable that would be is a very big ask. Evaluating how you look at growth and income stocks and derive an annual income also takes a lot of research and understanding, and even then there are no guarantees.

It’s so much easier to look at your house, which worked well for you over the 25 year term of your mortgage. And think of doing the same again, with BTL.

Know thyself

It might well be the right investment for you. But you can only say that once you’ve taken the time out to understand the more accessible alternatives, and what their advantages and disadvantages are compared to BTL. You must have a very good reason to throw out the only free lunch in finance – portfolio diversification. Just knowing that ‘everybody needs to live somewhere’ isn’t good enough. Everybody needs oil, but that didn’t stop people taking a hit on BP a while ago, and nobody needs anything made by Apple, but they made a good investment of late.

Balancing the opportunity costs is one of the things that makes investing hard. When you buy an asset, you’re also making the decision to not buy a different asset. Diversification derisks this, by stopping you putting all your money in one type of asset.

BTL is emotive in Britain, carrying the hopes of the ageing baby boomers who tend to have a high cost lifestyle and are distrustful of the financial system because they’ve just seen a huge financial crisis and may not have been lifestyle profiling their investments. And conversely carrying the unrealised aspirations of the Gen Y/echo boomers who want to buy houses around now, and who are finding prices running away from them and mortgage funding harder to find.

It’s difficult to believe that BTL is right for so many people, with its toxic mix of illiquidity, gearing, lack of geographical and sector diversification and hard to quantify risks and opportunities. If I said I was going to take out a mortgage to invest on the stock market most people would say I’m nuts. It’s not that clear to me why the same doesn’t apply to speculating on the housing market. BTL makes sense if it’s 10% of a diversified portfolio. As 100% of someone’s retirement savings it looks like a recipe for disaster to me. It isn’t just the return on capital that matters. The return of capital also matters.